In their first meeting late last month, a group of 16 legislators, tax attorneys, and members of the governor’s office formally began studying Utah’s tax system to make recommendations to Utah’s legislature that will both ensure stable sources of revenue for the state to provide public services and reduce tax costs to Utah’s economy overall.
Conversations about starting to tax services, which currently go largely untaxed in Utah, have been taking place for some time now. Many are wondering if taxes do go up, how much families in Utah will need to tighten their belts. At the same time, the Tax Restructuring and Equalization Task Force’s mandate is seen by others as a generational opportunity to review and reform Utah’s outdated revenue structure and tax code.
Based on our economic research, it is clear that the best path for continued prosperity in Utah is in lowering overall rates and broadening the base.
But to make sure that tax changes improve the economy, it would be helpful for the task force to commit —from the start — that any changes will be revenue neutral: any broadening of the sales tax base should be met with off-setting cuts to sales or income tax rates.
The fundamental motivation for changing Utah’s tax regime is the changing nature of American commerce. In 1933, physical goods accounted for 52% of national consumption. Today in Utah, it’s closer to 37% as more people are spending a larger portion of their incomes on services.
The path forward, according to economists, is to broaden the tax base and lower rates. Research on tax policy finds that taxes should apply to all consumption, whether goods or services. Low rates are key to economic growth because taxes become more and more disruptive as they increase. For example, a 4% tax rate is 4 times more harmful for Utah’s economy than a 2% tax rate.
Not only should the harms of increasing tax rates be avoided, but various methods for levying taxes should also be considered. Compare income taxes and sales taxes — because income taxes make saving and investing less profitable, they create compounding economic losses both now and in the future. That’s why tax experts generally prefer consumption taxes like Utah’s sales tax — it only changes how consumers react today. If you save part of your income, rather than spend it, you pay no sales tax right now, but you pay income taxes either way.
Of course, consumption taxes have their own tradeoffs. Taxing consumption means taxing necessities like groceries. That raises the costs of groceries and hits poorer households the hardest. Yet the usual response to this problem, exempting all groceries (or taxing them at a lower rate, as Utah currently does), is an inexact response. It means that ramen noodles and caviar both receive favorable tax treatment, even though few of us would classify caviar as a necessity.
Better policies would offer a direct tax credit to low-income families for groceries or limit the tax-exempt groceries to a narrow list, like Utah’s existing Women Infant and Children (WIC) list, which provides nutrition advice and pays for approved foods for low-income families. And this is not a pie-in-the-sky idea: four states already provide an offsetting credit to account for taxes on groceries, including neighboring Idaho.
Another option is creating an earned income tax credit (EITC). This policy offers a tax credit for income that individuals earn. Importantly, the EITC is more targeted towards individuals in need than sales tax exemptions. That makes it more effective at helping low-income populations and less expensive for the state.
As Utah’s tax reform task force continues this summer, its members will consider a variety of big ideas. Creating a tax system that lowers rates overall by closing exemptions and replacing broad policies with targeted solutions like the EITC would be just such an idea. Let’s just make sure that the end result is good tax reform, rather than tax increases.
Josh T. Smith is a research manager at the Center for Growth and Opportunity at Utah State University. Jeremy Horpedahl is an assistant professor of economics at the University of Central Arkansas. They coauthored a short primer published by the Center for Growth and Opportunity on what should be included in a state tax base. You can follow them on Twitter: @smithtjosh and @jmhorp.